Definition:
Assignment of accounts receivable is a financial arrangement where a company transfers ownership of its accounts receivable to a third party, typically a factor, in exchange for cash. This process is often used to improve a company’s cash flow by converting its accounts receivable into cash more quickly.
Key points about assignment of accounts receivable:
- Factoring: The third party that purchases the accounts receivable is often referred to as a factor.
- Discount: The factor typically purchases the accounts receivable at a discount to their face value, which is known as the factoring fee.
- Recourse vs. non-recourse: Assignments can be recourse or non-recourse. In a recourse assignment, the seller remains liable for any uncollectible accounts. In a non-recourse assignment, the factor assumes the credit risk.
- Financial statements: Assignment of accounts receivable can affect a company’s financial statements, as it can reduce the amount of accounts receivable on the balance sheet and increase cash flow.
Why is assignment of accounts receivable used?
- Improved cash flow: Assignment of accounts receivable can help to improve a company’s cash flow by converting accounts receivable into cash more quickly.
- Reduced credit risk: Non-recourse factoring can help to reduce a company’s credit risk by transferring the risk of uncollectible accounts to the factor.
- Financing option: Assignment of accounts receivable can be a source of financing for businesses, especially those with limited access to other forms of financing.
However, it’s important to note that assignment of accounts receivable can have costs, such as factoring fees and potential loss of control over customer relationships.
In essence, assignment of accounts receivable is a financial arrangement where a company transfers ownership of its accounts receivable to a third party in exchange for cash, which can be a useful tool for improving cash flow and managing credit risk.
